How Putting Together an Emergency Fund Works

Because it may require a tight budget, starting an emergency fund can be a daunting task. Once you know how much you need, you have to figure out how to accumulate the money. You may have to cut back on some discretionary expenses like eating out or buying a new pair of shoes every week. But knowing that you have a safety net can make it much easier to make the sacrifice.

One way to start your emergency fund is to set up an automatic draft so that a part of every paycheck goes into your emergency fund. If you never see the money, you won't miss it, and you won't be as likely to spend it elsewhere.

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Be sure to set up a separate account for your emergency fund. Don't make it a checking account -- that makes it too easy to use the money for other things. Make sure it isn't attached to an ATM card or any other easy-to-access features. You want to get to the money if you need it, but not just because you found a set of bedroom furniture you couldn't resist.

Using a money market account for an emergency fund can help you make money on your savings while you aren't using it. Money markets draw more interest than basic savings or checking accounts, and you can still get to the money if you need it.

Don't be disappointed if your emergency fund takes a long time to build. Set up a plan for how much you'll contribute to the fund each month based on the amount of time you want to allow for building the balance. If you try to reach your goal too quickly, you'll either miss the goal and get discouraged, or you'll have to give up all the fun and entertainment in your life in the name of savings.

People think very differently about emergency funds. Some advisors suggest deferring 401(k) payments for a few months to get an emergency fund going; others say that the loss of long-term 401(k) benefits far outweighs the benefits of an emergency fund. Research 401(k) plans and determine for yourself how important the emergency fund is to you.

If you work at it, you can build a fund large enough to provide a safety net that will last several months. It can help you feel better about tomorrow, knowing that you are prepared to face a crisis, should one arrive. And if you don't face a crisis, you can feel good about having a nest egg. Either way, getting started on an emergency fund is a step in the right direction.

Swimming in Debt

If you have extensive credit card debt, most advisors would say that you should pay that down before putting money into an emergency fund. After all, you probably won't receive more than five percent interest on a savings account, but your credit cards can cost you upward of 10 percent. Put an extra week's cash aside for emergencies and pay off those bills. Then, you can start building up your emergency fund.